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Accounting, Auditing and Governance for Takaful Operations

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Accounting, Auditing and Governance for Takaful

Operations

Sheila Nu Nu HtayMohamed Arif

Younes SoualhiHanna Rabittah Zaharin

Ibrahim Shaugee

John Wiley & Sons Singapore Pte. Ltd.

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Copyright © 2013 by John Wiley & Sons Singapore Pte. Ltd.

Published by John Wiley & Sons Singapore Pte. Ltd., 1 Fusionopolis Walk, #07–01, Solaris South Tower, Singapore 138628

All rights reserved.

No part of this publication may be reproduced, stored in a retrieval system, or transmitt ed in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as expressly permitt ed by law, without either the prior writt en permission of the Publisher, or authorization through payment of the appropriate photocopy fee to the Copyright Clearance Center. Requests for permission should be addressed to the Publisher, John Wiley & Sons Singapore Pte. Ltd., 1 Fusionopolis Walk, #07–01, Solaris South Tower, Singapore 138628, tel: 65–6643–8000, fax: 65–6643–8008, e-mail: enquiry@wiley.com.

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Typeset in 11/14 pt, Arno Pro by MPS Limited, Chennai, India.Printed in Singapore by Markono Print Media.

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Contents

Foreword ix

Preface xi

Acknowledgments xv

1 Introduction to Takaful and Retakaful 1

Learning Outcomes 1Introduction 2History of Insurance and Takaful 2Differences between Takaful and Conventional Insurance 4Shariah, Legal, and Regulatory Framework of Takaful 7The International Association of Insurance Supervisors (IAIS) and

Islamic Financial Services Board (IFSB) 13Different Types of Takaful Models 14An Overview of Retakaful 22Conclusion 31Chapter Questions 31Notes 31References 32

2 Takaful Companies and Their Accounting Environment 33

Learning Outcomes 33Introduction 34The Concept of Accounting in Business

and Its Historical Development 34

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vi / CONTENTS

Malaysian Accounting Environment 35International Accounting Standard Setting Bodies 48Malaysian Insurance Institute 49Conclusion 50Chapter Questions 50References 50

3 Prevailing Accounting Standards and Accounting Entries for Takaful Operators 53

Learning Outcomes 53Introduction 54Guidelines on Financial Reporting for Takaful Operators 54AAOIFI FAS 12: General Presentation and Disclosure in the Financial

Statements of Takaful Companies 55AAOIFI FAS 13: Disclosure of Bases for Determining and

Allocating Surplus or Defi cit in Takaful Companies 58AAOIFI FAS 15: Provisions and Reserves in Takaful Companies 59AAOIFI FAS 17: Investments 61AAOIFI FAS 18: Islamic Financial Services Offered by

Conventional Financial Institutions 62AAOIFI FAS 19: Contributions in Takaful Companies 62Accounting Entries 63Conclusion 99Chapter Questions 99References 102

4 Financial Statement Analysis 103

Learning Outcomes 103Introduction 104Financial Ratios for General Takaful Funds 104Financial Ratios for Family Takaful Funds 107Financial Ratios for Shareholders’ Funds 110Conclusion 113Chapter Questions 113References 113

5 Zakat Computation and Distribution for Takaful and Retakaful Companies 115

Learning Outcomes 115Introduction 116Zakat and the Islamic Worldview 116Zakat Computation Methods (AAOIFI) 120Suggested Disclosure Information 122Conclusion 123Chapter Questions 123Notes 123References 123

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CONTENTS / vii

6 Auditing and Governance for Takaful Operators 125

Learning Outcomes 125Introduction 126An Overview of the Auditing Standards 126Suggested Guide for Shariah Audit 128Practical Implementation 129Governance for Islamic Finance 136Conclusion 151Chapter Questions 152References 152

Appendix 1: Sample Audit Proposal 155

Appendix 2: Audit Plan Timeline 167

Appendix 3: Audit Program 169

Appendix 4: Report on Shariah Compliance Audit for Takaful X Sdn. Bhd. as of 31 March 2011 171

Contents 1721. Executive Summary 1732. Aims and Objectives 1773. Background/Introduction 1784. Shariah Audit Methodology 1825. Shariah Audit Findings and Result 183

About the Authors 197

Index 199

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Foreword

Th e establishment of an Islamic bank in Malaysia, in the early 1980s, generated signifi cant inter-est in the populace for an institution that would fulfi l a prevailing need for an alternative to conventional insurance in order to complement and supplement the insurance needs of Islamic banking. Th is interest, coupled with a fatwa declaring conventional insurance as a void contract due to its Shariah -noncompliant elements, issued by the Malaysian National Fatwa Council in 1972, prompted the government to establish a working team of Islamic scholars, legal experts, and insurance practitioners, called the “Special Task Force to Study the Incorporation of an Islamic Insurance Company in Malaysia.” I was aff orded the privilege of serving as a member of the Task Force. Arising out of the recommendations of the Task Force, a Takaful Act was enacted in 1984 and the fi rst takaful operator was incorporated in November 1984.

Since its inception the Malaysian takaful industry has seen monumental growth, from a single entity with relatively limited products, to one that is well integrated into the mainstream fi nancial system. Over the years the industry has registered double-digit growth constantly, and has proven to be extremely resilient despite the intense competition from a well-established, well-fi nanced conventional insurance sector, as well as economic upheavals. Th e eff orts of the takaful operators as well as Bank Negara have to be commended. It was these resolute eff orts that made the achievements of the Malaysian takaful industry possible.

As a person who built its foundation and had been working in the Malaysian takaful industry for more than two decades and seen its development fi rst hand, I cannot help but feel extremely proud—proud not only of the phenomenal growth the industry has already achieved but mostly of the fact that takaful keeps on growing by leaps and bounds, pointing to an extremely bright future. However, in our pride we should not ignore the challenges facing the industry.

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x / FOREWORD

One such challenge is talent development. To maintain such rapid growth the industry demands adequate supplies of knowledgeable and competent human talent. Th e operators are constantly on the lookout for human talent that would take the industry to the next level.

Malaysia has medium- and long-term plans to develop this requisite human talent. A key component of these plans is academic programs off ered by various educational institutions. For these programs to be successful, proper materials, including books, are needed. Lack of books and writings on takaful was a key challenge that we faced during the initial development of taka-ful . Today this is not so. Th ere are a number of books available on takaful . However, there is still a noticeable lack of books on specialised areas of takaful —accounting and auditing are two such areas. As such, this book is not just another book on takaful . It does fi ll a gap. It is writt en in a language that is straightforward and easy for an average man to understand, and at the same time avoids oversimplifi cation that might put off professionals. Th is book provides a one-source alternative for knowledge of every aspect of takaful operations—from the basic principles to accounting entries. I take this opportunity to thank the authors for their eff orts in writing this book, which I am sure will form a must-read for anyone interested in takaful . May Allah make this eff ort a success and bless their future endeavours.

Dato’ Mohd Fadzli Yusof

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Preface

What started as a search by Muslim scholars and political economists for an alternative to the economic and fi nancial system forced upon the Muslim world aft er their colonisation has today developed into a thriving industry that has witnessed rapid evolution and expansion within the past decade. Th is is visible not only in the Islamic world but in the Western world as well, signify-ing its robustness and vigor in the face of the fi nancial crises that rocked the major economies of the world. It is no longer a product off ered to a niche market but a genuine fi nancial alternative with presence in more than 60 countries of the world with assets worth billions of dollars.

What started as a collection of mostly banking institutions has evolved into a comprehen-sive system consisting of a robust takaful (Islamic insurance) sector as well as other nonbanking fi nancial institutions. While the success of Islamic fi nance is typically signifi ed by the number and strength of Islamic banking institutions, the role of takaful should not be underestimated. Th e suc-cess and development achieved by the takaful sector is especially impressive when it is placed in the context of insurance penetration rates in Muslim countries, which typically tend to be very low.

In contemporary times, Islamic fi nance is considered one of the fastest-growing areas of international fi nance. Th e span of Islamic fi nance and takaful is growing remarkably fast not only in the Gulf region but also in non-Muslim countries. Expansion in the takaful business has been robust in recent times.

Th e demand for takaful and diff erent takaful products is quite strong and consequential. Islam is the fastest growing religion and constitutes the second largest religion in the world. Present era Muslims are looking for religion-based solutions to the problems they face.

Th e achievements of the takaful sector and the potential for future growth, underlined by increasing affl uence and positive demographic changes, paint a very positive picture of the

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xii / PREFACE

future for the industry. To reach its potential, the sector has to be anchored on stable institutional foundations—none more important than human capital. Institutions such as the IIUM Institute of Islamic Banking and Finance (II i BF) have already put in place robust programs to develop talents that would take the Islamic fi nance industry to the next level. Th is book is aimed at pro-viding proper material that can be used as a part of academic curriculums of such a program.

A comprehensive curriculum needs to address each and every aspect of the program and needs to be supplemented by easy-to-get references, including textbooks. While there currently are a multitude of books on Islamic fi nance in general and takaful specifi cally, there seems to be a lack of texts on the accounting and auditing aspects related to takaful. Th is book is aimed at fi ll-ing this gap. It is hoped that this book can help guide the educational journey of students inter-ested in takaful as well as act as a useful reference guide to accounting and auditing practitioners in the takaful sector and the Islamic fi nancial industry at large.

About the Contents Chapter 1 is presented as an introduction to takaful (Islamic insurance). Th rough the discus-sions in this chapter, the reader should be able to grasp a basic understanding of the history and development of conventional insurance as well as takaful . Th is discussion also encompasses the diff erences between these two concepts. Furthermore, this chapter also explains the Shariah , legal and regulatory framework behind takaful operations, as well as the basic takaful models being practised around the world.

Chapter 2 focuses on accounting and its relationship with takaful operators. Th is chap-ter starts out with a brief explanation of what accounting is and how it was developed. Aft er that, the discussion is aimed at providing a brief look at the operating environment of takaful operators—specifi cally the accounting and governance aspects. Th is includes the accounting and governance standards and guidelines as well as the organisations that set them. Th e discus-sion in this chapter is mostly focused on the standard-sett ing organisations and institutions.

Chapter 3 provides a detailed look at the fi nancial reporting requirements of a takaful operator. Th e emphasis of this chapter is mostly on the requirements of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards for takaful opera-tors. Furthermore, this chapter also provides typical journal entries that a takaful operator has to pass in order to record its transactions, including retakaful.

Chapter 4 discusses fi nancial statement analysis. Th e discussion is from the perspective of a takaful operator; hence, it is diff erent from a typical fi nancial statement analysis. Th e ratios discussed in this chapter include underwriting, profi tability, as well as liquidity ratios. Th e ratios are grouped according to the source of funds—general takaful fund, family takaful fund, and shareholders’ fund. Readers should be able to calculate the ratios as well as describe the results and make sense of the fi nancial statements of a takaful operator aft er reading this chapter.

Chapter 5 focuses on zakat —computation and distribution—for takaful operators. Th e discussion starts with an introduction to zakat and its relationship to the Islamic worldview. Aft er that, the discussion moves on to zakat computation for takaful operators. Th e discussion

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PREFACE / xiii

here is based on the methods suggested by the AAOIFI. Aft er discussing computation, the chap-ter ends with a look at the disclosure requirements as suggested by the AAOIFI.

Chapter 6 provides a detailed look at the auditing and governance standards that a taka-ful operator has to follow. Th e standards discussed include those set by the AAOIFI, the Islamic Financial Services Board (IFSB), Bank Negara Malaysia (BNM), and Bursa Malaysia.

Background and Readership Th is book is intended as an introduction to accounting, auditing, and governance issues related to takaful operations for students, practitioners, and the general public who may be interested in the inner workings of the takaful industry. With this readership in mind, the book has been writt en in such a way that a reader would have no diffi culty understanding the content. Special care was given to ensure that less technical jargon was used and that the language was kept as simple as possible. Similarly, with the potential dryness of the subjects being discussed in mind, every att empt has been made to keep the discussion interesting through the use of easy-to-understand examples and fi gures.

Although the book is seen as an introduction to accounting, auditing, and governance issues related to takaful operations, we have assumed that readers will be acquainted with the very basic concepts of Islamic fi nance. As an integral part of the burgeoning Islamic fi nance land-scape, proper understanding of takaful requires an understanding of Islamic fi nance. Despite the importance of Islamic fi nance as a theoretical foundation for the issues being discussed in this book, it is not within the scope of this book to discuss those principles.

Relationship with Other Books While a large number of books have been writt en on Islamic fi nance and to a slightly less degree on takaful , books concentrated on accounting and auditing for takaful operators are extremely limited. Although takaful is unique as a product and industry, students and practitioners cur-rently do not have any references on accounting and auditing techniques, principles, and proce-dures applied and used by takaful operators. Th e only alternative they have is to rely on books writt en on accounting for insurance companies. However, the unique nature of takaful makes this an unsatisfactory compromise. While students and practitioners do have limited books on accounting for Islamic fi nancial institutions available for reference, the institutions focused on in these books are mostly banks and other similar institutions. Th erefore, this book is targeted at fi lling this gap.

While the writers view the material related to accounting and auditing presented in this book as mostly unique, the reader can refer to a number of other books to gain knowledge of basic Islamic fi nance concepts to act as a foundation and, at the same time, to enhance their understanding of basic takaful principles and operations discussed in this book.

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